Central Pacific Financial Corp (CPF) 2006 Q4 法說會逐字稿

Good day, and welcome, to the Central Pacific Financial Corporation fourth quarter earnings call. Today's call is being recorded. This call may contain forward-looking statements concerning projections of revenues income earnings per share, capital expenditures, dividends, capital structure, or other financial items concerning plans and objectives of management for future operations, concerning future economic performance, or concerning any of the assumptions underlined or relating to any of the foregoing. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and may include the words believe, plans, intends, expects, anticipates, forecasts, or words of similar meaning.

While we believe that our forward-looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risks and uncertainties and thus could later to prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections for a variety of reasons to include but not limited to the impact of local, national, and international economies and events, including natural disasters on the company's business and operations and on tourism, the military, and other major industries operating within the markets we serve.

The impact of legislation affecting the banking industry, the impact of competitive products, services, and pricing, and other competitive forces. Movements in interest rates, loan delinquency rates, and changes in asset quality generally and the price of the company's stock.

For further information on factors that could cause actual results to materially differ from projections, please see the company's publicly available Securities and Exchange Commission filings including the company's Form 10-K for the last fiscal year. The company does not update any of its forward-looking statements.

And now at this time for opening remarks and introductions, I would like to turn the call over to Mr. Clint Arnoldus, Chief Executive Officer, please go ahead, sir.

Thank you Dana, and thank you all for joining us today to review Central Pacific Financial Corp.'s financial performance for the fourth quarter and for the year ended 2006. With me here today are Curtis Chinn our Chief Risk Officer and Dean Hirata our Chief Financial Officer. I'll be addressing the highlights of our company and our marketplace and Dean will follow with a detailed financial report of the fourth quarter and our year-end result following which we'll entertain questions.

I'm very pleased to report the Central Pacific Financial Corp. realized another solid quarter with earnings of $18.8 million, bringing the net income for the year 2006 to $79.2 million or an increase of 9.3% over 2005. Loan growth has been strong throughout the year, including an increase of $80.9 million in the fourth quarter over the previous quarter. Commercial real estate lending continues to be strong in our west coast offices, which contributed to approximately half of our fourth quarter loan growth.

For the year, our loans and lease balances increased by $293.3 million or 8.3% from a year ago. Deposit growth was also solid throughout the year capped with an increase of $62.6 million in the fourth quarter over the previous quarter. Non-interest bearing demand deposits contributed significantly to our fourth quarter deposit growth.

Our core deposit acquisition strategies revolving around our flagship program, the exceptional account have generated a significant number of new household relationships in our retail segment. Our promotional campaigns have also solidified and increased our deposit relationships with our current customers. As of December 31st, 2006, total deposits increased by $202.2 million or 5.6% from a year ago. In addition to the strong organic growth we've realized in loans and deposits, we've continued to significantly improve our asset quality. As of December 31st, nonperforming assets declined from 24 basis points of total assets in 2005 to 16 basis points in 2006.

I'd like to take just a moment to update you on the progress of our BSA compliance initiatives and fulfilling the provisions contained in the FDIC order that we received on November 29th, 2006. I'm very pleased to report that we're on schedule in meeting the deadlines included in the order to enhance our policies and procedures for monitoring large currency transactions and suspicious activity. In addition, we completed the installation of a specialized software program to better monitor suspicious activity going forward.

These efforts have had no material impact on our day-to-day business operations or on the service quality that we provide to our customers. BSA compliance remains a top priority for us and we are confident that we will be in full compliance with the order by mid 2007.

This time, I want to share a few highlights of the economic climate in the state of Hawaii. Overall, the economy remains stable, but with a continued trend toward cooling compared to the robust activity that we experienced in 2005. Similar to the softening conditions on the mainland United States, the leading indicators for Hawaii are expected to grow at a slower pace in 2007.

Inflation rate in Hawaii topped 5% in 2006 driven by housing and energy costs and is expected to exceed 4% in 2007. Real personal income adjusted for inflation increased by 2.8% last year and is forecasted to increase by 1.8% in 2007. Visitor arrivals were relatively flat in 2006 increasing by .4% over the previous year but are expected to rise by 2% this year primarily from the U.S. market.

Hotel occupancy rates continue to be high, but the Japanese market will continue to be soft due to increases in hotel room rates and large fuel surcharges. In the labor market, job growth realized a 2.6% increase in 2006, but is expected to decelerate to a growth rate of 1.5% in 2007. Unemployment at a record low in October of last year at 2.1%. However, is expected to edge upward to an average of 2.9% in 2007.

Construction activity is leveled off and will be a factor in the expected cooling of job growth this year. Housing prices are currently flat and projected to decline slightly in 2007. Overall, the outlook for the local economy in 2007 is for a continued soft landing from the economic surge in 2005. Federal spending remains very stable while construction activity and visitor arrivals are expected to plateau in the coming year.

Moving forward, we maintain our focus on selective market segments where we can be optimally successful. High value retail relationships, small businesses, and real estate lending continue to be our primary growth segments.

We plan to open new full service branches in two strategic market areas, subject to FDIC approval. The first branch will be in Pearl City on the island of Oahu, which is scheduled for the third quarter of this year. And the secondary we're targeting is Lahaina on the island of Maui.

With this expansion, our branch network will include 40 branch offices and over 90 ATMs. We're very proud to have been recognized in 2006 for several statewide achievements. Including being named one of the best places to work among the large corporations. SBA lender of the year for the third consecutive year in our category, and receiving the national philanthropy outstanding corporation award.

With our highly motivated employees and desire to serve our community, we're very confident that our company will continue to grow its share of markets in 2007. At this time, I'd like to turn the call over to our CFO Dean Hirata to review the details of our fourth quarter and year-end financial performance. Dean?

Thank you, Clint. My review will cover the consolidated financial highlights for Central Pacific Financial Corp. and its subsidiaries for the 2006 fourth quarter and year.

There was a fair amount of noise in the current quarter that I would distill for you in my review of our financial performance. The fourth quarter 2006 net income was $18.8 million, including an after tax charge of $.9 million or 3 cents per diluted share from the previously announced investment portfolio repositioning of $109 million in available for sale investment securities.

Of second, there was a $1.1 million tax charge or 3 cents per diluted share for adjustments to the prior year tax liability and third an after tax charge of $.5 million or 2 cents per diluted share for adjustments to certain employee benefits related liabilities. Excluding these three charges, net income for the fourth quarter of 2006 was $21.3 million, an increase of 10% over the same quarter last year and 3.4% on a sequential quarter basis. On a diluted per share basis, net income was 61 cents for the current quarter.

Excluding the charges previously discussed, net income for the fourth quarter of 2006 was 69 cents per diluted share, a 9.5% increase over the same quarter last year, and a 3% increase over the third quarter of 2006. Net income for 2006 was $79.2 million, including the charges previously discussed and an after tax charge of $1.3 million or 4 cents per diluted share in retirement expenses for a former senior executive recorded in the first quarter of 2006.

Excluding these charges, net income for 2006 was $83 million, an increase of 9.5% over operating earnings for 2005. We find this net income adjusted for nonrecurring merger related expenses.

On a diluted per share basis, net income was $2.57 for 2006. Excluding the charges previously discussed, net income for 2006 was $2.69 per diluted share, an increase of 8% over 2005 operating earnings per diluted share.

Looking at the key performance ratios, again based on our normalized 2006 net income for both the fourth quarter and year respectively were as follows:

Return on assets of 1.58% and 1.57%.

Return on tangible equity of 20.99% and 22.01%.

Return on equity of 11.56% and 11.7%.

An efficiency ratio of 52.05% and 48.49% and a net interest margin of 4.49% and 4.55%.

Total loans and leases of 3.8 billion as of Decembe31st, 2006 grew by $293 million or up 8.3% over December 31st, 2005. On a link quarter basis, the increase was $81 million or up 2.1% unannualized. Average loan balances increased by 2.2% sequentially. The average year end loans for the fourth quarter of 2006 was 7.85%. An increase of 80 basis points over the prior year due to the upwards repricing of loans. On a link quarter basis, the increase was 7 basis points.

Total deposits of $3.8 billion as of December 31st, 2006 increased by $202 million or up 5.6% over December 31st, 2005. On a sequential quarter basis, the increase was $63 million or 1.7% unannualized.

The increase was due to organic growth in all deposit categories led by growth in our flagship exceptional savings account and non-interest bearing demand deposits. Average deposit balances increased by 3.4% sequentially. The effective cost of interest bearing liabilities for the current quarter was 3.21%, an increase of 98 basis points over the prior year. And on a link quarter basis, the increase was 18 basis points.

Looking now at our earnings, and starting with the net interest margin of 4.49% for the fourth quarter of 2006, which did decrease by 20 basis points compared to the same quarter last year and decreased by 7 basis points on a link quarter basis.

The compression in the net interest margin reflected higher funding cost due to repricing of maturing deposits and borrowing combined with a shift in the deposit mix to higher rate time deposits as a result of strong competition in the Hawaii market for time deposits, which was then offset by a modest increase in loan yield expansion. There was no provision for loan and lease losses for the current quarter compared to $1 million in the same quarter last year and $300,000 in the third quarter of 2006. Again, reflecting the improvement in asset quality over the prior year.

Other operating income was $9.5 million for the current quarter, a decrease of 17.3%, compared to the same quarter last year. The decrease was primarily due to a $1.5 million loss from the investment portfolio repositioning of $109 million in available for sale investment securities.

As a result of the repositioning, we reduced our interest rate risk exposure to declining market interest rates while also improving our 2007 net interest income. The decrease in other operating income also reflects a 37% decline in mortgage origination activity from Central Pacific home loans compared to the year ago quarter.

On a link quarter basis, other operating income was down 10% primarily due to the investment portfolio repositioning. Are partially offset by a 23% increase in mortgage origination activity during the current quarter. Other operating expense was $35.7 million for the current quarter compared to $32.8 million in the same quarter last year and $31.2 million in the third quarter of 2006.

The increase of the prior year was primarily due to the adjustment of $.9 million, for certain employee benefit accruals, stock option expensing, higher advertising and professional fees, and reduced loan origination cost deferrals. The increase over the third quarter of 2006 was primarily due to the employee benefit adjustment discussed previously and higher incentive compensation expense and legal and professional fees.

The effective rate on income taxes was 30.81% for the current quarter compared to 35.34% in the same quarter last year and 35.86% in the third quarter of 2006. The decrease in the effective tax rate compared to the prior year and on a link quarter basis reflects high technology investment and energy conservation leases which resulted in a $1.4 million net federal and state tax credit, partially offset by a $1.1 million tax charge for adjustments to the prior year tax liability. The rate of return on these high technology investments is highly dependent on the state tax credit and to a lesser extent factors into the pricing of the leases.

Asset quality remains strong. Nonperforming assets at December 31st, 2006 totaled $9 million or 16 basis points of total assets, down from $12.6 million or 24 basis points a year ago. On a sequential quarter basis, nonperforming assets increase from $8 million or 15 basis points as of September 30, 2006.

The increase in nonperforming assets during the current quarter reflects the addition of a $3.5 million commercial loan, offset by the full payoff of a $2.6 million commercial real estate loan. Nonperforming assets are mainly comprised of loans fully secured by commercial and residential properties and no losses are anticipated at this time.

Loans delinquent for 90 days or more and still accruing interest totalled $909,000 at December 31st, 2006, compared to $7.9 million a year ago and $2.8 million as of September 30, 2006. Net loan chargeoffs were $331,000 in the current quarter compared to $809,000 in the year ago period and $603,000 in the third quarter of 2006.

Loan chargeoffs in the current quarter included a $1.5 million partial chargeoff of a commercial loan, the balance of which was transferred to non-accrual status as discussed previously. Loan recoveries in the current quarter included $1.9 million in commercial mortgage and commercial loan recoveries from a single borrower.

The allowance for loan and lease losses as a percentage of total loans and leases was 1.36% as of December 31st, 2006 and is reflective of our solid asset quality ratios and the continued economic strength in our markets. [Inaudible] equity at December 31st, 2006, increased to 738.4 million or a tangible equity ratio of 7.89%.

Looking at the forecast for 2007, the forecast is based on the following assumptions: Net interest income will be driven by expected loan growth in the range of 6% to 8%. Deposit growth of 5-7% partially offset by compression in the net interest margin to the 4.4-4.5% range. Balance sheet sensitivity due to an inverted to flat yield curve is expected to be offset by expected loan growth. Secondly, asset quality will remain strong. And third we will continue to manage overhead costs in order to sustain a strong efficiency ratio.

Based on these assumptions and current and anticipated economic and business conditions, management is forecasting diluted earnings per share for 2007 in the range of $2.80 to $2.90.

This concludes my review of Central Pacific financial results for the 2006 fourth quarter and year. And I'll now turn the call back over to Clint.

We'd be happy to entertain any questions any of you have at this time.

Thank you, sir.

[OPERATOR INSTRUCTIONS] And we'll go first to Brett Rabatin of FTN Midwest.

Hi Clint, hi Dean, how are you?

Hey Brett. We're doing fine, thanks.

Couple questions for you. First off, I need some help if you guys could on the tax stuff you had during the quarter. The way I look at it is the net of the two adjustments for the taxes in the fourth quarter is you basically had a $.3 million benefit to the tax rate, but when I make that adjustment, I still come up with a tax rate somewhat lower than usual. So I'm curious of if I'm missing something on that and you gave some prepared comments about going forward. The timing of those transactions on the high technology credits are, they come as they come. So if you had any thoughts also on a full-year tax rate for '07, that would be helpful too.

Brett, this is Dean. Again, on the effective tax rate, in addition to those two items that we discussed in the fourth quarter, there are additional state tax credits in connection with these high technology investments we've made in prior years. And then combined with that is higher holding income during the quarter along with some additional tax exempt income from both the loan and securities portfolio.

Okay. And any thoughts then on normalized or just sort of a not even normalized what a full-year tax rate for '07 might look like? That's implied in your guidance?

Approximately between 34-35%.

Okay. And then secondly I wanted to get any color you guys could share on the, on the link quarter increase and expenses specifically how much of the fourth quarter was a reflection of incentive compensation? How much you guys ended up putting towards the BSA in the fourth quarter and how much of that might still be left going forward, and how much the -- what you call the FAS 91 or the origination cost referrals impacted the quarter.

Okay. Starting with the impact of the additional incentives, that was approximately $1 million in additional accruals due to the performance for the year. On the legal fees, there was some additional costs of approximately $300,000 as well as $200,000 for BSA related costs. And then with -- in connection with the high technology investments we made in the fourth quarter, that investment is amortized proportionately to the recognition of the state tax credit. And that was approximately an amortization expense of $1.1 million. In addition to that, there were some seasonal expenses for approximately $300,000. Going forward, you know, we expect that the other operating expense run rate will be somewhere between 31.5-32.5 million.

Okay. That's great color. And last question on that topic. Last quarter, the production on the mortgage side was lower than you guys had talked about lowering expenses as it relates to that. But obviously in the fourth quarter, you had better production. I'm curious to hear how the cost structure on the mortgage side played out in the fourth quarter?

Again, that's, like I said, we -- based on our forecast for the origination activity and that's looking at about approximately $210 million of per quarter. We have started to look at the overall infrastructure and we continue to look at that, but I don't have anything further to report at this time.

Okay. And then just one last question on in your guidance you mentioned that your assumption is for asset quality to remain strong and I don't mean to put additional levers in your guidance, but does that assume credit trend similar to the fourth quarter and provisioning might remain light given the relative reserve level and your guys' very strong asset quality?

Brett, this is Curtis Chinn. Yes, we do expect that quality, for the most part, to remain consistent with what we've seen of late so that would suggest as long as that continues, the provisioning would be similar.

Okay. Great. Thanks, guys.

And we'll go next to Thomas Monaco of Front [inaudible] Investment Management.

Hi, thank you for taking my call. Can you, I guess, give us a little more clarity on, I guess the regulatory order, when you expect it to be lifted and what some of the restrictions are?

The order had specifically 12 points that we needed to comply with. And we're largely completed on many of those. And we were, we stated that we had a target of mid year 2007 to have to be in compliance with the full order and we expect that that date is still good. We're making very excellent progress. The installation of the software was probably the most difficult of the steps that we had. And that's been installed and we're in the fine tuning stages right now. So we expect, as I said to be in full compliance by mid year 2007.

Okay, thank you.

And we'll go next to Brent Christ of Fox-Pitt.

Thanks, guys. Most of my questions have already been asked. But in terms of the deposit growth in the quarter, it looks like end- of -period balances you had quite a nice spike in the demand deposit category verses the average balances were actually down a bit. Was there anything going on there driving that difference?

Again, part of that -- again it's seasonal we do see at the end of the year, we have seen some pull back on that. But again, the growth during the quarter like I said we did show strong growth in both the exceptional count as well as the stabilize, you get some fluctuations in the demand deposit accounts.

Okay. Next in terms of your 6-8% loan growth outlook for '07, if you could break that down kind of between expectations for the mainland verses Hawaii.

Yes, it's Curtis Chinn again. The break down is roughly 30% of the growth, which comes from the mainland which is primarily real estate driven. 70% would be from Hawaii, split between real estate and non-real estate. It's roughly 50/50.

Okay. Great. And then just the last question in terms of the expense run rate, I just wanted to make sure I heard it correctly. You're saying a good run rate kind of heading into '07 is 31.5-32 million per quarter? If you X out all the noise for this quarter?

Correct.

Okay.Thanks a lot guys.

Before we go to the next question. If I could just clarify an earlier response and I think this was to Brett's question with regards to the provisioning. Again, we do expect the asset quality to remain strong. But with the expected loan growth, we do expect to have a provision in 2007 of approximately $3.5 million so that the ratio itself will continue to trend down and we expect that it'll be closer to about 1.3% by the end of the year based on the expected loan growth.

And we'll take our next question from Joe Morford of RBC Capital Markets.

Thanks, good afternoon, everyone or morning for you. I -- couple questions. First the -- I guess can you give us a little more color on the nature of the $3.5 million CNI credit that came into nonperforming loan category this quarter and just any other comments on classified trends in general?

Yes, the 3.5 million that went to nonperforming was related to a line of credit for a contractor. And the issues were that really they had problems on two very large contracts issues were underbidding and [inaudible] compounding that. It was an isolated situation.

And is this your entire exposure to this borrower?

Yes.

Okay. And classified trends in general?

Classified trends in general are trending down over the past year.

Okay.

Hopefully we can [inaudible] that.

Okay. And lastly, with -- given the work on the BSA side suggests that perhaps acquisitions are unlikely in the near term until that's lifted. Is there consideration to using some excess capital to buy back stock in the interim?

Again, Joe, this is Dean. Again, in connection with our capital management program, you know, in addition to looking at the dividend. You know, we do look at the buy backs and as you know, we do have authorization to repurchase up to 600,000 common shares. So, you know, that is something that we will continue to look at, but keeping in mind also the overall CRE of concentration and the offset for capital, the required capital that we need in connection with that portfolio.

Okay. Thanks, Dean.

And we'll go next to Mike McMahon of Sandler O'Neill and Partners.

Well, between Brent and Joe, I'm finished, thank you.

We'll move on to Fred Cannon of KBW.

Yes, I'm -- I think I'm pretty well covered. Just a couple quick questions. I was wondering on the high-tech investment tax credit you're getting, I was wondering if you could talk about the sustainability of that and are those -- are those tax credits at any risk? And do you think you'll be able to continue to get the good benefits you saw in the previous quarter moving forward?

Yes, on these investments, we've been investing in these high-tech credits since 2002. And that was in connection with some state tax legislation to promote the emerging growth high-tech industries. And we would expect that going forward we will continue to look to these types of investments. The rate of return that we earn on these credits are purely from the state tax credit. And as far as the realization of recognition of those credits, we're very assured that we will realize those credits. I'll say again going forward, you know, we will continue to have investments, you know, with these types of investments. And again, it's in line with just the overall industry -- emerging growth industries that the state is trying to promote.

Thanks. And one thing, follow-up to Joe's question on capital management, your tangible equity to asset ratio, I think picked up to a little over 8% at the end of the year. Is there any guidance on kind of, you know, given the statement you made, Dean about the commercial real estate exposure et cetera. Is there a certain level that we should kind of anticipate there that you guys think is the right overall level? So is there any other guidance you can give us on that? It would appear especially since your blocked out from doing deals until the BSA thing is lifted - and you have 6-8% loan growth, capital could continue to grow pretty rapidly.

I mean long-term we've always targeted somewhere between 7.5-8.5%. But definitely we'd want to be with the concentration north of 7% at this time.

Okay. Great. Thanks very much.

[OPERATOR INSTRUCTIONS] We'll have a follow-up from Brett Rabatin of FTN Midwest.

Yes, hi, just wanted to ask a follow-up on the mainland production. I know last time I think I talked to you, Curtis, you mentioned were selectively limiting exposure in some areas of real estate, just not wanting to be aggressive with either the inland empire, construction, or what have you. So I'm curious on the guidance for lower mainland production and if that's a concerted effort to reduce growth in some aspect of the real estate portfolio and if there's any parts of the portfolio that you're not looking to grow on a relative basis and whether it be concentration by credit or what have you?

The slow down in the growth rate is really a function of slow down in markets. Developers are just not developing as much so naturally our volume is going way down with that. Where we are tightening up a little bit, if you will in the residential construction area. And land related to residential, I guess. The market is self-correcting and self-disciplined, [inaudible]. So we are really tracking the market.

Okay. Thank you.

And gentlemen, there are no further questions at this time. I'll turn the call back over to you for any additional or closing remarks.

Thank you. I appreciate you calling in today. I appreciate your continuing interest in our company. We feel very positive about the guidance we provided and are going to work hard to achieve those numbers that we relate to you today. We'll talk to you in a quarter.

And that does conclude today's conference call, if you'd like to listen to an audio replay of today's call, you may do so by dialing 1-888-203-1112 and entering the access code of 9419023. The replay of today's call will be available starting this evening at 6 p.m. central time, and ending on Tuesday, January 30th at midnight central time. You may now disconnect. Thank you for your participation.